British GBP/EUR Exchange Rate FORECAST: GBP/EUR Could Rise for Years - GBP LATEST

Interest rates are a key driver to forex valuations as they tend to reflect the underlying economic strengths of a currency zone; and with markets getting back to normal after years of turmoil they will become increasingly dominant.

For reference this Wednesday, we see the following mid-market rates at the time of writing:

• The pound to euro exchange rate is 0.27 pct higher on a day-to-day basis at 1.2442.
• The pound to dollar exchange rate is 0.27 pct higher at 1.6833.
• The pound to Aus dollar exchange rate is 0.12 pct higher at 1.7915.
• The pound to NZ dollar exchange rate is 1.11 pct lower at 1.9419.

Beware, the above mid-market rates will attract a discretionary spread from your bank or FX provider. An independent provider will guarantee to undercut your bank's offer, thereby delivering up to 5% more currency. Please learn more here.

Why is the pound sterling (GBP) higher today?

Sterling is up by 0.2% vis-à-vis the USD following a positive employment report, which saw employment rise by 345k in the three months to April – the strongest gain since records began in 1971. 

The unemployment rate fell 0.2 pps to 6.6%.  Despite these encouraging metrics, wage growth was undeniably weak, with headline wage growth slipping from 1.9% to 0.7% Y/Y, and ex-bonuses falling from 1.3% to 0.9% Y/Y (mkt 1.2% for both).

"In all, one could argue that the very subdued pace of real wages will perhaps carry more weight for BoE policy than the progress being made in employment, as the former implies less inflationary pressures in the pipeline," says Shaun Osborne at TD Securities.

Interest rate differentials are key to the pound euro rate forecast

This week we heard that long-term gains in the pound euro rate have been hinted at by ECB Executive Board member Benoit who stated that Eurozone interest rates will diverge from rates in the UK and USA for years.

"As central banks in Britain and the US raise rates, the yield differential will help weaken the EUR which should assist in importing disinflation and hurting Europe's fragile economic recovery," says Peter Rosenstreich at Swissquote Bank.

However, beware short-term euro strength

However, it is worth keeping in mind that the GBP/EUR is likely to continue treading a rocky path higher.

Short-term declines are increasingly possible thanks to the relatively overbought conditions witnessed in the GBP/EUR.

The pair's Relative Strength Index is near 70, a suggestion that a correction is due.

Analysts at Barclays have meanwhile forecast that near-term weakness will ultimately be smoothed out by longer-term fundamentals.

Analyst Marvin Barth writes:

"The temporary rebound in the EUR post ECB meeting is puzzling, but does not change our view. Short-term market dynamics are often difficult to explain, but fundamentals always prevail over any reasonable horizon, as demonstrated by the EUR’s depreciation since the ECB’s May meeting commitment to ease policy.

"Both market pricing – note the huge inversion of the short-term vol curve for EURUSD – and anecdotes strongly suggest that FX market participants were long volatility going into yesterday’s ECB meeting, and the rebound may be related to position management.

"But we remain convinced that the ECB has turned a corner, both in its own commitment and its credibility with markets, to raise inflation. The associated decline in real interest rates should push the EUR lower."

Exchange Rates Today: Volatility remains low

The currency markets, which have for the most part been so quiet of late and have been trading at record low levels of volatility, suddenly woke up on Thursday around the time of the ECB announcement.

"This led to a very volatile trading day in the currency markets, but not one that has as yet influenced or changed the long-term trends, all of which still remain intact," says Phil Seaton at LS Trader.

However, we could be seeing volatility sinking once again with Monday seeing little excitement with a light economic data calendar on tap.

"FX volatility continues to fall and with vacation in France, traders should expect FX to be range bound. Equity volatility has fallen near a seven year low," says Rosenstreich.

Traders will be watching Canadian housing starts, expected to fall to 185k vs. 195.3k revised prior read. The stronger CNY fix aided AUD/USD up but still below the 0.9356 high reported after the US NFP data release.

AUD remains well bid in the crosses ahead of Thursday's RBNZ meeting where traders expected high probability of another 25 bps rate hike.